An estimated 15 million Americans turned to small-dollar credit products in 2011. These individuals used payday loans, pawn loans, direct deposit advance, auto title loans and nonbank installment loans in order to obtain quick access to cash. Yet, these types of credit often come with high fees and challenging repayment terms (such as two week balloon payments) that make it highly unlikely the loans will be repaid without significant difficulty. As a result, many borrowers rollover or extend their loans multiple times, finding themselves in a cycle of repeat usage and mounting debt.
The lack of safe, affordable, high quality small-dollar credit options – and other solutions that will solve the problems for which people currently turn to credit – is a major pain point for underserved consumers. But meeting this need with high quality advice, products and services is also a significant business opportunity.
According to new research by the Center for Financial Services Innovation and Core Venture Capital, fees paid to access these small dollar credit products in 2011 amounted to $17 billion. This is revenue that should be shifted toward products and services that meet the need for credit in a way that aligns provider and customer success and builds economic opportunity for consumers – rather than seeing those opportunities stripped away.
Developing the innovative new products and services that are necessary to meet this goal will not be an easy effort. Listening to the experiences of these individual borrowers is the right place to start. CFSI hopes to contribute to this goal through a new consumer research study we've just released on small-dollar credit consumers.
Our findings show, even within the small-dollar credit category, different products are used for different needs. Products with shorter terms (payday and pawn) are more likely to be used for everyday living expenses, while installment loans are more likely to be used for larger or more infrequent purchases such as auto repair. Digging one step further into "why you borrowed" suggests that some borrowers have a structural mismatch in which their expenses exceed their income; some borrowers are solving for an emergency expenditure and some have a timing disconnect in which their bills and income are misaligned.
Nearly two-thirds of survey respondents reported having no savings. However, among the other third, more than half chose not to use all of their savings and relied upon very expensive credit options instead.
When considering credit options, access and speed were most important to potential borrowers.
While more than half of payday borrowers repay their loans within two weeks, a significant number of consumers rollover, renew or extend their loans multiple times. Our study found that the average payday consumer takes 11 loans or extensions per year and is in debt for approximately 150 days.
Finally, borrowers with a high loan-to-income ratio or those who report having expenses that consistently exceed their income are more likely to roll over or extend their loan repayment across nearly all the products CFSI examined.
Underserved consumers deserve access to a variety of safe, affordable, high quality credit options that are suited to their particular credit need and financial situation. CFSI's research suggests that developing these types of products requires satisfying a tall order of criteria. This criteria starts with budgeting and advice and savings, and then when credit is the right solution, balancing sound underwriting to determine ability to repay with speed, convenience and accessibility.
It is a tall order, but the potential rewards for consumers and providers are immense. Listening to the consumer is the start.
Rachel Schneider and Rob Levy are vice president and manager, respectively, on the Insights and Analytics team at the Center for Financial Services Innovation.